Non-traditional secondary buyers: a GPs perspective

The private equity secondary market, once dominated by a few large specialist buyers, is witnessing the emergence of a growing number of “non-traditional” buyers who are entering the secondary fray. Like specialist buyers, these non-traditional buyers, including endowments, foundations and pension funds, purchase private equity interests to achieve the attractive return and diversification benefits associated with the investment style. Non-traditional buyers, however, have some motivations that distinguish them from the specialist buyers. From a general partner's perspective, these differences have a number of important implications.

One of the most important characteristics that differentiate non-traditional buyers from specialist buyers is the desire of many non-traditional buyers to develop long-term relationships with general partners. For example, an endowment may consider a secondary purchase as a means to gain access to a general partner with a solid track record or to establish a relationship with a promising new fund manager. In either case, the non-traditional buyer typically approaches a secondary transaction with the intention of supporting the general partner in future funds. The general partner is thus able to replace the exiting limited partner with an institutional limited partner who can provide a long-term source of capital.

The relationship focus of non-traditional buyers, however, can prove to be a “double-edged sword” to general partners. Whereas specialist buyers tend to be more focused on the shorter-term prospects for a fund's portfolio companies, non-traditional buyers tend to place a greater emphasis on the quality of the fund management team, the fund investment strategy, and the manager's performance track record. When conducting due diligence on a secondary transaction, a non-traditional buyer often requires more time and a greater amount of information in order to grow comfortable with the investment opportunity. The investment team members may spend as much time with a non-traditional secondary buyer as they would with a potential new investor when raising a primary fund.

General partners should also recognize the fact that most non-traditional secondary buyers are less experienced than specialists in conducting secondary transactions. Since non-traditional buyers may be less familiar with the language of standard purchase-sale agreements, the negotiation and closing process may require additional time.

Although the relationship focus and inexperience of non-traditional buyers may place a resource burden on the general partner, the potential strategic benefits may be well worth the effort. For example, if a marquis institutional investor purchases a secondary interest in a fund, it may send a positive signal to the market and may help validate the fund manager's investment strategy. The addition of a “brand name” endowment or pension to a fund's slate of limited partners can serve as a valuable asset when the manager raises subsequent funds in the future.

Finally, because of lower cost of capital and higher access premiums, there is an increased probability that a secondary transaction involving a non-traditional buyer will occur at above-average pricing. A higher transaction price may enable the general partner to preserve a positive relationship with the exiting limited partner, allowing the firm to maintain good relations with the investor community.

As endowments, foundations and pension funds increasingly look to the secondary market as a portfolio management tool, general partners need to be aware of the characteristics that distinguish these non-traditional buyers from secondary specialists. Although non-traditional buyers may require additional time and information to complete a purchase, fund managers often benefit from the long-term, strategic nature of these relationships.

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Cogent Partners is a private equity-focused investment bank dedicated to serving the needs of the private equity community. Cogent Partners represents sellers in traditional and securitised secondary transactions, conducts detailed portfolio assessment and pricing analysis, and provides fairness assessments for secondary buyers and sellers. For more information on Cogent Partners or the private equity secondary market, please visit the firm's website at www.cogent-partners.com
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